Intermediate Accounting,17EStice | Stice | SkousenPowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine University 2010 Cengage LearningInvestments in Noncurrent Operating Assets Utilization and Retirement11-2Depreciation The use of assets during the period should be reported as an expense of that period. Accountants estimate this cost by using a systematic method to allocate the recorded costs, called: Depreciation for tangible property, such as equipment. Depletion for minerals and natural resources. Amortization for intangible assets, such as patents and copyrights.(continues)11-3 Depreciation is not a process through which a company accumulates a cash fund to replace its long-lived assets. Depreciation 11-4Factors Affecting the Periodic Depreciation Charge Asset cost Residual or salvage value Useful life Pattern of use11-5Depreciation Vocabulary Asset cost is the purchase cost plus any capitalized expenditures. Residual (salvage) value is the estimated resale value of the asset upon retirement. Useful life is the expected life of the asset in years, hours of service, or per unit of output.11-6Pattern of UseCosts incurred are deferred until future periods. They are recorded as an asset and the costs are assigned to future periods.DepreciableDepreciable CostCost (Asset)(Asset)Period 2Period 2Period 3Period 3Period 1Period 111-7Pattern of Use The allocation of a deferred cost, in this case depreciation expense, has no direct effect on cash. The allocation is based on the depreciable cost, useful life, and depreciation method.11-8Straight-Line DepreciationTime-Factor MethodsTime-Factor MethodsStraight-line depreciation relates depreciation to the passage of time and recognizes equal depreciation in each year of the life of the asset.11-9Straight-Line DepreciationSchuss Boom Ski Manufacturing acquired a polyurethane plastic- molding machine at the beginning of 2011 for $100,000. It has an estimated life of five years and an estimated residual value of $5,000. (continues)11-10Depreciation =Cost Residual Value Number of YearsDepreciation =$100,000 $5,000 5Depreciation =$19,000Straight-Line Depreciation11-11Sum-of-the-Years Digits MethodSYD =n (n + 1) 2SYD =5 (5 + 1) 2SYD = 15The sum-of-the-years-digits depreciation method yields decreasing depreciation in each successive year. To determine the denominator, use the following formula (assuming 5 years):(continues)11-12Sum-of-the-Years Digits MethodtDepreciation =SYD (Cost Residual value)Depreciation =515 ($100,000 $5,000)Depreciation = $31,667Now that we know the denominator, we can determine the depreciation for the year using the following formula, where “t” equals years remaining at the beginning of the period.(continues)11-13Sum-of-the-Years Digits MethodFor the second year, we reduce the numerator by one.tDepreciation =SYD (Cost Residual value)Depreciation =415 ($100,000 $5,000)Depreciation = $25,33311-14Declining-Balance Method The declining-balance depreciation method provides decreasing charges by applying a constant percentage rate to a declining asset book value. First, the constant percentage must be calculated. If double-declining balance depreciation is used, then the percentage is twice the straight-line rate. 11-15Declining-Balance MethodS/L rate = 1 n Thus, the molding machine would have a straight-line rate of 20% (1 5). This number is doubled to arrive at the double-declining percentage of 40%. 11-16Use-Factor MethodsUse-factor depreciation methods view asset exhaustion as related primarily to asset use or output and provide periodic charges varying with the degree of such services.11-17Service-Hours DepreciationThe first use-factor method we will examine is service-hours depreciation. This method is based on the theory that the purchase of an asset represents the purchase of a number of hours of direct service.11-18Lets continue with the Schuss Boom Ski Manufacturing machine. It cost $100,000 and had a residual value of $5,000. It is estimated that the machine will perform for an estimated service life of 20,000 hours. Now we can determine the rate to be applied to each service hour. Service-Hours Depreciation11-19Depreciation =Cost Residual valueNumber of hoursDepreciation = $4.75 per hourService-Hours DepreciationDepreciation =$100,000 $5,00020,000 hours11-20Productive-Output DepreciationProductive-output depreciation is based on the theory that an asset is acquired for the service it can provide in the form of production output. Assume a company produced 3,200 units in 2011 and 5,400 units in 2012.11-21Productive-Output DepreciationRate per unit =Cost Residual value Total number of unitsRate per unit =$100,000 $5,00025,000 unitsRate per unit = $3.80 per unit2011: 3,200 units $3.80 = $12,160 Annual depreciation for